Last week was volatile as the S&P 500 declined near the lower range of our 5,100-to-5,500 trading range early in the week, then surged on de-escalation on the trade war and Trump/Powell feud to end the week near the upper range, just above 5,500.
There were several legitimate reasons for last week’s rally including (in order of importance): De-escalation of the trade war with China (Bessent said the tariffs were unsustainable, Trump stated negotiations with China were taking place and China reduced tariffs on some U.S. import categories), de-escalation of the Trump/Powell feud (Trump said he has no intention of firing Powell), rising anticipation for the announcement of numerous trade deals (Korea, India and Japan are reportedly close) and Q1 earnings, especially from the tech sector, have been solid.
All of these are positive, and the S&P 500 did appropriately rally. However, none of these events are materially bullish, and while still-negative sentiment helped the S&P 500 temporarily break through 5,500 on some good earnings or further trade de-escalation briefly, I do not think the news has turned good enough to sustain a rally.
Here’s why... First, the Trump vs. Powell fight is not over. Trump understands that firing Powell would hammer markets, so he (probably) won’t try it, but that doesn’t mean the negative headlines are done. The Fed meets next on Wednesday, May 7, and the Fed is very unlikely to cut rates at that meeting and that could draw Trump’s ire, especially if economic data begins to show growth is slowing (and inflation is rising).
Second, we should all expect significant tariff reduction and that’s positive compared to the worst-case scenario, but it’s not “good” in an absolute sense compared to the start of the year, where there were virtually no tariffs on U.S. imports. Regardless of what level of tariff reduction we see, the baseline level of tariffs will be much higher than it was in January and that will be a headwind on growth and a tailwind on inflation.
Now, I’m not in the camp that thinks these tariffs automatically mean the return of stagflation. Yes, it’s a risk, but the economy deserves the benefit of the doubt. At the same time, I’m not dismissive of the risks to growth and inflation that higher tariffs pose. Regardless of whether tariffs cause a recession, they are negative for growth, and the only question is by how much.
Finally, while Q1 earnings have been solid (corporate America is truly amazing at pulling levers to maintain profitability), these numbers don’t reflect the new reality of tariffs and reduced demand for U.S. assets, and it is very unlikely that 2025 S&P 500 EPS expectations stay at $270. A $10/share reduction to $260 (or even lower) seems more appropriate. That’s still earnings growth over 2024, but it’s more on trend, and a $260 earnings number leaves the market multiple at 21X, a very high valuation for an economy staring down stagflation.
Bottom line: Last week was positive, but it wasn’t positive enough to alter my outlook that this market is still mostly rangebound between 5,100 and 5,500 in the S&P 500. Nor does it change my outlook that defensive sectors such as value plays and fixed income plays are the best places to “hide” in this market, while still maintaining longer-term exposure. Some of you who hold American funds should know that I am making some moves there and do need to talk to each of you who hold American Funds. Lee Ann is scheduling those calls.
Finally, for those looking to “take a shot,” the tech earnings season has been solid and the thawing of U.S./China trade tensions is directly beneficial for tech stocks, so taking a position in technology has some merit to it for those who can hold it, although obviously we have to understand the increased volatility that comes with it.
I am maintaining a 50% position in value/fixed income positions for the foreseeable future, but will make a change back to equities if the tariff cloud begins to diminish. Stay the course and the second half of this year looks very promising.
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